What exactly is meant by the term “periodic inventory system”?
A system that takes inventories only on a periodic basis does not maintain continuous records of ending inventories or the cost of products sold. On the other hand, this information is tallied up at the close of each fiscal year, quarter, or other accounting period.
The process of managerial decision-making is hampered by the adoption of this strategy, despite the fact that it simplifies the maintenance of records.
On the other hand, the sheer number of transactions that take place in certain retail businesses renders it impossible to employ any other system than the periodic one.
Journal Entries for the Accounting Done Using the Periodic Inventory System
The following illustration provides a sample of the diary entries required to properly record inventories when using the periodic system. The process of perpetual inventory is demonstrated by the information presented in the sample data.
When using the periodic technique, the cost of the inventory that was sold for a specific transaction is not recorded.
In addition, contrary to what can be deduced from the journal entries, purchases of stock do not result in a reduction of the balance in the merchandise inventory account. Instead, they are accumulated in a separate account designated for purchasing transactions.
As a direct result of this, there are no entries made to the merchandise inventory account throughout the period.
Consequently, before any adjustment entries are made, the balance in the merchandise inventory account will reflect the amount of inventory at the beginning of the year, as shown in the T-accounts that are listed below.
Figuring Out the Cost of the Goods That Were Sold and Taking Inventory
Calculating the cost of goods sold during the period and the ending inventory is a necessary step in the process of preparing financial statements using the periodic inventory method.
The sum of the firm’s beginning inventory and the goods it has purchased during the time symbolizes all of the company’s products that are currently available for purchase.
Once the ending inventory has been subtracted from this total, the amount that is left over represents the cost of the items that were sold.
The periodic income and the financial situation can be determined with the help of determining the cost of the closing inventory as well as the cost of the goods sold. The resulting numbers are recorded in the journal entries.
In accordance with the periodic inventory method, adjusting and closing entries will be performed.
After it has been determined how much the ending inventory and cost of goods sold were, the accounts need to be adjusted so that they accurately reflect the amount of the ending inventory and the cost of the products sold.
The formula that is used to compute the cost of goods sold serves as the foundation for the adjusting entry. Consequently, the sum of the merchandise inventory at the beginning and the purchases brings the total number of goods that are accessible for sale.
To calculate the balancing debit to the cost of goods sold, the credit for item inventory at the end of the period is removed from the total amount.
Beginning and ending labels are affixed to the merchandise inventory for the sake of ease. Despite this, there is only one account in the ledger and that is for the merchandise inventory.
Note that the product inventory account is brought up to its correct ending balance as a result of this adjusting entry. This is done so that the purchases account can be cleared out and a cost of goods sold account can be created.
The cost of products sold cannot be computed with precision using this method, despite the fact that it requires one fewer entry. Nevertheless, the preparation of the revenue statement cannot be done without this account.